Rocky Mountain Chocolate Factory, Inc. - Quarter Report: 2019 May (Form 10-Q)

 

 

Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended May 31, 2019

 

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ________to________

 

Commission file number: 001-36865

 

Rocky Mountain Chocolate Factory, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware	47-1535633
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

 

265 Turner Drive, Durango, CO 81303

(Address of principal executive offices, including zip code)

 

(970) 259-0554

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class	Trading symbol	Name of each exchange on which registered
Common Stock, $0.001 par value per share	RMCF	Nasdaq Global Market
Preferred Stock Purchase Rights	RMCF	Nasdaq Global Market

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer      ☐	Accelerated filer                     ☐
Non-accelerated filer        ☐	Smaller reporting company    ☒
	Emerging growth company    ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

 

On June 25, 2019, the registrant had outstanding 5,965,827 shares of its common stock, $0.001 par value.

 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

 

FORM 10-Q

 

TABLE OF CONTENTS

 

 

PART I.

FINANCIAL INFORMATION

3

Item 1.

Financial Statements

3

	CONSOLIDATED STATEMENTS OF INCOME	3
	CONSOLIDATED BALANCE SHEETS	4
	CONSOLIDATED STATEMENTS OF CASH FLOWS	5
	CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY	6
	NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	22
Item 4.	Controls and Procedures	22

PART II.

OTHER INFORMATION

23

Item 1.	Legal Proceedings	23
Item 1A.	Risk Factors	23
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 3.	Defaults Upon Senior Securities	24
Item 4.	Mine Safety Disclosures	24
Item 5.	Other Information	24
Item 6.	Exhibits	25
Signature		26

 

PART I.     FINANCIAL INFORMATION

 

		Three Months Ended May 31,
		2019				2018
Revenues
Sales		$	6,460,611			$	6,582,049
Franchise and royalty fees			1,965,388				1,784,036
Total Revenue			8,425,999				8,366,085
Costs and Expenses
Cost of sales			4,614,744				4,665,242
Franchise costs			483,013				493,250
Sales and marketing			556,651				588,250
General and administrative			1,144,731				914,447
Retail operating			448,902				562,472
Depreciation and amortization, exclusive of depreciation and amortization expense of $145,699, $136,505, respectively, included in cost of sales			231,955				301,000
Costs associated with Company-owned store closures			-				58,188
Total costs and expenses			7,479,996				7,582,849
Income from Operations			946,003				783,236
Other Income (Expense)
Interest Expense			(12,398	)			(22,639	)
Interest Income			10,179				4,577
Other income (expense), net			(2,219	)			(18,062	)
Income Before Income Taxes			943,784				765,174
Income Tax Provision			232,175				188,230
Consolidated Net Income		$	711,609			$	576,944
Basic Earnings per Common Share		$	0.12			$	0.10
Diluted Earnings per Common Share		$	0.11			$	0.10
Weighted Average Common Shares Outstanding - Basic			5,962,278				5,905,414
Dilutive Effect of Employee Stock Awards			272,286				77,594
Weighted Average Common Shares Outstanding - Diluted			6,234,564				5,983,008

---

 

		May 31,				February 28,
		2019				2019
		(unaudited)
Assets
Current Assets
Cash and cash equivalents		$	5,895,574			$	5,384,027
Accounts receivable, less allowance for doubtful accounts of $557,916 and $489,502, respectively			3,877,170				3,993,262
Notes receivable, current portion			140,452				110,162
Refundable income taxes			4,534				190,201
Inventories, less reserve for slow moving inventory of $171,651 and $371,147, respectively			4,016,264				4,270,357
Other			440,173				318,126
Total current assets			14,374,167				14,266,135
Property and Equipment, Net			5,855,457				5,786,139
Other Assets
Notes receivable, less current portion			357,877				281,669
Goodwill, net			1,046,944				1,046,944
Franchise rights, net			3,521,112				3,678,920
Intangible assets, net			479,601				498,337
Deferred income taxes			569,393				607,421
Lease right of use asset			3,280,508				-
Other			63,384				56,576
Total other assets			9,318,819				6,169,867
Total Assets		$	29,548,443			$	26,222,141
Liabilities and Stockholders' Equity
Current Liabilities
Current maturities of long term debt		$	829,941			$	1,176,488
Accounts payable			1,126,472				897,074
Accrued salaries and wages			732,313				655,853
Gift card liabilities			715,700				742,289
Other accrued expenses			271,863				293,094
Dividend payable			715,899				714,939
Contract liabilities			238,194				256,094
Lease liability			851,249				-
Total current liabilities			5,481,631				4,735,831
Lease Liability, Less Current Portion			2,429,259				-
Contract Liabilities, Less Current Portion			1,020,997				1,096,478
Commitments and Contingencies
Stockholders' Equity
Preferred stock, $.001 par value per share; 250,000 authorized; -0- shares issued and outstanding			-				-
Series A Junior Participating Preferred Stock, 50,000 authorized; -0- shares issued and outstanding			-				-
Undesignated series, 200,000 shares authorized; -0- shares issued and outstanding			-				-
Common stock, $.001 par value, 46,000,000 shares authorized, 5,962,327 shares and 5,957,827 shares issued and outstanding, respectively			5,962				5,958
Additional paid-in capital			6,882,114				6,650,864
Retained earnings			13,728,480				13,733,010
Total stockholders' equity			20,616,556				20,389,832
Total Liabilities and Stockholders' Equity		$	29,548,443			$	26,222,141

---

 

		Three Months Ended
		May 31,
		2019				2018
Cash Flows From Operating Activities
Net Income		$	711,609			$	576,944
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			377,654				437,505
Provision for obsolete inventory			23,766				24,185
Provision for loss on accounts and notes receivable			81,283				23,400
Asset impairment and store closure losses			-				44,000
Loss on sale or disposal of property and equipment			2,867				17,056
Expense recorded for stock compensation			231,254				155,807
Deferred income taxes			38,028				(54,493	)
Changes in operating assets and liabilities:
Accounts receivable			(100,089	)			672,005
Refundable income taxes			185,667				-
Inventories			344,058				(916,261	)
Contract Liabilities			(90,248	)			(78,883	)
Other current assets			(122,047	)			(168,990	)
Accounts payable			115,667				291,989
Accrued liabilities			28,640				349,987
Net cash provided by operating activities			1,828,109				1,374,251
Cash Flows from Investing Activities
Proceeds received on notes receivable			28,400				33,698
Proceeds from (cost of) sale or distribution of assets			-				500
Purchases of property and equipment			(283,548	)			(130,572	)
(Increase) decrease in other assets			312				(5,366	)
Net cash used in investing activities			(254,836	)			(101,740	)
Cash Flows from Financing Activities
Payments on long-term debt			(346,547	)			(333,955	)
Dividends paid			(715,179	)			(708,653	)
Net cash used in financing activities			(1,061,726	)			(1,042,608	)
Net Increase in Cash and Cash Equivalents			511,547				229,903
Cash and Cash Equivalents, Beginning of Period			5,384,027				6,072,984
Cash and Cash Equivalents, End of Period		$	5,895,574			$	6,302,887

---

 

		Three Months Ended
		May 31,
		2019				2018
Common Stock
Balance at February 28:		$	5,958			$	5,903
Repurchase and retirement of common stock			-				-
Issuance of common stock			-				-
Exercise of stock options, vesting of restricted stock units and other			4				2
Balance at May 31:			5,962				5,905
Additional Paid-in Capital
Balance at February 28:			6,650,864				6,131,147
Repurchase and retirement of common stock			-				-
Issuance of common stock			-				-
Exercise of stock options, vesting of restricted stock units and other			231,250				155,805
Balance at May 31:			6,882,114				6,286,952
Retained Earnings
Balance at February 28:			13,733,010				13,419,553
Consolidated Net income			711,609				576,944
Cash dividends declared			(716,139	)			(708,653	)
Adoption of ASC 606			-				925,929
Balance at May 31:			13,728,480				14,213,773
Total Stockholders' Equity		$	20,616,556			$	20,506,630
Common Shares
Balance at February 28:			5,957,827				5,903,436
Repurchase and retirement of common stock			-				-
Exercise of stock options, vesting of restricted stock units and other			4,500				2,000
Balance at May 31:			5,962,327				5,905,436

---

 

NOTE 1 – NATURE OF OPERATIONS AND BASIS OF PRESENTATION

 

Nature of Operations

 

The accompanying consolidated financial statements include the accounts of Rocky Mountain Chocolate Factory, Inc., a Delaware corporation, its wholly-owned subsidiaries, Rocky Mountain Chocolate Factory, Inc., a Colorado corporation (“RMCF”), Aspen Leaf Yogurt, LLC, a Colorado limited liability company (“ALY”), and U-Swirl International, Inc., a Nevada corporation (“U-Swirl”), and its 46%-owned subsidiary, U-Swirl, Inc. (“SWRL”), of which RMCF had financial control until February 29, 2016 (collectively, the “Company”). All intercompany balances and transactions have been eliminated in consolidation.

 

The Company is an international franchisor, confectionery manufacturer and retail operator. Founded in 1981, the Company is headquartered in Durango, Colorado and manufactures an extensive line of premium chocolate candies and other confectionery products. U-Swirl franchises and operates soft-serve frozen yogurt cafés. The Company also sells its candy in selected locations outside of its system of retail stores and licenses the use of its brand with certain consumer products.

 

In January 2013, through its wholly-owned subsidiaries, including ALY, the Company entered into two agreements to sell all of the assets of its ALY frozen yogurt stores, along with its interest in the self-serve frozen yogurt franchises and retail units branded as “Yogurtini,” which the Company also acquired in January 2013, to SWRL, in exchange for a 60% controlling equity interest in SWRL (46% equity interest as of May 31, 2019). Upon completion of these transactions, the Company ceased to directly operate any Company-owned ALY locations or sell and support frozen yogurt franchise locations, which were being supported by SWRL. The SWRL board of directors is composed solely of board members also serving on the Company’s board of directors (the “Board of Directors”).

 

In fiscal year (“FY”) 2014, SWRL acquired the franchise rights and certain other assets of self-serve frozen yogurt concepts under the names “CherryBerry,” “Yogli Mogli Frozen Yogurt” and “Fuzzy Peach Frozen Yogurt.” In connection with these acquisitions, the Company entered into a credit facility with Wells Fargo Bank, N.A. used to finance the acquisitions by SWRL, and in turn, the Company entered into a loan and security agreement with SWRL to cover the purchase price and other costs associated with the acquisitions (the “SWRL Loan Agreement”). Borrowings under the SWRL Loan Agreement were secured by all of the assets of SWRL, including all of the outstanding stock of its wholly-owned subsidiary, U-Swirl. As a result of certain defaults under the SWRL Loan Agreement, the Company issued a demand for payment of all obligations under the SWRL Loan Agreement. SWRL was unable to repay the obligations under the SWRL Loan Agreement, and as a result, the Company foreclosed on all of the outstanding stock of U-Swirl on February 29, 2016 in full satisfaction of the amounts owed under the SWRL Loan Agreement. This resulted in U-Swirl becoming a wholly-owned subsidiary of the Company as of February 29, 2016, and concurrently the Company ceased to have financial control of SWRL as of February 29, 2016. As of May 31, 2019, SWRL had no operating assets.

 

U-Swirl operates self-serve frozen yogurt cafés under the names “U-Swirl,” “Yogurtini,” “CherryBerry,” “Yogli Mogli Frozen Yogurt,” “Fuzzy Peach Frozen Yogurt,” “Let’s Yo!” and “Aspen Leaf Yogurt”.

 

The Company’s revenues are currently derived from three principal sources: (i) sales to franchisees and other third parties of chocolates and other confectionery products manufactured by the Company; (ii) sales at Company-owned stores of chocolates, other confectionery products and frozen yogurt (including products manufactured by us); (iii) the collection of initial franchise fees and royalties from franchisees.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

The following table summarizes the number of stores operating under the Rocky Mountain Chocolate Factory brand and frozen yogurt cafés at May 31, 2019:

 

 

Basis of Presentation

 

The accompanying consolidated financial statements have been prepared by the Company, without audit, and reflect all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting and Securities and Exchange Commission (the “SEC”) regulations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the consolidated financial statements reflect all adjustments (of a normal and recurring nature) which are necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented. The results of operations for the three months ended May 31, 2019 are not necessarily indicative of the results to be expected for the entire fiscal year.

 

These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended February 28, 2019.

 

Subsequent Events

 

Management evaluated all activity of the Company through the issue date of the financial statements and concluded that no subsequent events have occurred that would require recognition or disclosure in the financial statements.

 

Recent Accounting Pronouncements

 

In August 2018, the SEC adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification. These amendments eliminate, modify, or integrate into other SEC requirements certain disclosure rules. Among the amendments is the requirement to present an analysis of changes in stockholders’ equity in the interim financial statements included in Quarterly Reports on Form 10-Q. The analysis, which can be presented as a footnote or separate statement, is required for the current and comparative quarter and year-to-date interim periods. The amendments are effective for all filings made on or after November 5, 2018. In light of the anticipated timing of effectiveness of the amendments and expected proximity of effectiveness to the filing date for most filers’ quarterly reports, the SEC’s Division of Corporate Finance issued a Compliance and Disclosure Interpretation related to Exchange Act Forms, (“CDI – Question 105.09”), that provides transition guidance related to this disclosure requirement. CDI – Question 105.09 states that the SEC would not object if the filer’s first presentation of the changes in shareholders’ equity is included in its Quarterly Report on Form 10-Q for the quarter that begins after the effective date of the amendments. As such, the Company adopted these SEC amendments on November 30, 2018 and is first presenting the analysis of changes in stockholders’ equity in its interim financial statements in this Quarterly Report on this Form 10-Q. The adoption of these SEC amendments did not have a material effect on the Company’s financial position, results of operations, cash flows or stockholders’ equity.

 

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 significantly changes the impairment model for most financial assets and certain other instruments. ASU 2016-13 will require immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets, which will generally result in earlier recognition of allowances for credit losses on loans and other financial instruments. ASU 2016-13 is effective for the Company's fiscal year beginning March 1, 2020 and subsequent interim periods. The Company is currently evaluating the impact the adoption of ASU 2016-13 will have on the Company's consolidated financial statements.

  

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires the recognition of lease assets and lease liabilities on the balance sheet by lessees for those leases currently classified as operating leases under ASC 840 “Leases.” These amendments also require qualitative disclosures along with specific quantitative disclosures.

 

The Company adopted ASU 2016-02 as of March 1, 2019, using the modified retrospective method. This method allows the new standard to be applied retrospectively through a cumulative catch-up adjustment recognized upon adoption. As a result, comparative information in the Company’s financial statements has not been restated and continues to be reported under the accounting standards in effect for those periods. The Company recorded a Right of Use Asset and Lease Liability on the Consolidated Balance Sheet of $3.3 million upon adoption. The impact of the new standard did not affect the Company’s cash flows or results of operations. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the lease term, which includes options that are likely to be exercised, discounted using an incremental borrowing rate or implicit rate.

 

 

NOTE 2 - EARNINGS PER SHARE

 

Basic earnings per share is calculated using the weighted-average number of common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur from common shares issuable through stock options and restricted stock units. For FY 2019 and FY 2018, no stock options were excluded from diluted shares as there were no stock options outstanding. Restricted stock units become dilutive within the period granted and remain dilutive until the units vest and are issued as common stock.

 

 

NOTE 3 – INVENTORIES

 

The Company held the following inventory at May 31, 2019 and February 28, 2019:

 

 

 

NOTE 4 - PROPERTY AND EQUIPMENT, NET

 

Property and equipment at May 31, 2019 and February 28, 2019 consisted of the following:

 

 

 

NOTE 5 - STOCKHOLDERS’ EQUITY

 

Cash Dividend

 

The Company paid a quarterly cash dividend of $0.12 per common share on March 16, 2018 to stockholders of record on March 6, 2018. The Company paid a quarterly cash dividend of $0.12 per share of common stock on June 15, 2018 to stockholders of record on June 5, 2018. The Company paid a quarterly cash dividend of $0.12 per share of common stock on September 14, 2018 to stockholders of record on September 4, 2018. The Company paid a quarterly cash dividend of $0.12 per share of common stock on December 7, 2018 to stockholders of record on November 23, 2018. The Company declared a quarterly cash dividend of $0.12 per share of common stock on February 14, 2019, which was paid on March 15, 2019 to stockholders of record on March 5, 2019. The Company declared a quarterly cash dividend of $0.12 per share of common stock on May 28, 2019, which was paid on June 14, 2019 to stockholders of record on June 4, 2019.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

Future declarations of dividends will depend on, among other things, the Company's results of operations, financial condition, capital requirements, and on such other factors as the Company's Board of Directors may in its discretion consider relevant and in the best long-term interest of the Company’s stockholders.

 

Stock Repurchases

 

On July 15, 2014, the Company publicly announced a plan to repurchase up to $3.0 million of its common stock in the open market or in private transactions, whenever deemed appropriate by management. On January 13, 2015, the Company announced a plan to purchase up to an additional $2,058,000 of its common stock under the repurchase plan, and on May 21, 2015, the Company announced a further increase to the repurchase plan by authorizing the purchase of up to an additional $2,090,000 of its common stock under the repurchase plan. The Company did not repurchase any shares during the three months ended May 31, 2019 or 2018. As of May 31, 2019, approximately $638,000 remains available under the repurchase plan for further stock repurchases.

 

Stock-Based Compensation

 

Under the Company’s 2007 Equity Incentive Plan (as amended and restated) (the “2007 Plan”), the Company may authorize and grant stock awards to employees, non-employee directors and certain other eligible participants, including stock options, restricted stock and restricted stock units.

 

The Company recognized $231,254 of stock-based compensation expense during the three months ended May 31, 2019 compared with $155,807 during the three months ended May 31, 2018. Compensation costs related to stock-based compensation are generally amortized over the vesting period of the stock awards.

 

The following table summarizes non-vested restricted stock unit transactions for common stock during the three months ended May 31, 2019 and 2018:

 

 

The Company issued 4,500 fully vested, unrestricted shares of stock to non-employee directors during the three months ended May 31, 2019 compared to 2,000 shares issued during the three months ended May 31, 2018. In connection with these non-employee director stock issuances, the Company recognized $42,525 and $24,480 of stock-based compensation expense during the three months ended May 31, 2019 and 2018, respectively.

 

During the three months ended May 31, 2019, the Company recognized $188,729 of stock-based compensation expense related to non-vested, non-forfeited restricted stock unit grants. The restricted stock units generally vest between 17% and 20% annually over a period of five to six years. Total unrecognized stock-based compensation expense of non-vested, non-forfeited restricted stock units, as of May 31, 2019, was $2,461,553, which is expected to be recognized over the weighted average period of 4.94 years.

 

During the three months ended May 31, 2019, the Company granted 270,000 shares of restricted stock units with a grant date fair value of $2,536,100 or $9.39 per share, compared with no restricted stock units awarded in the three months ended May 31, 2018. The restricted stock unit grants vest between 17% and 20% annually over a period of five to six years.

 

The Company has no outstanding stock options as of May 31, 2019.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

 

NOTE 6 – SUPPLEMENTAL CASH FLOW INFORMATION

 

 

 

NOTE 7 - OPERATING SEGMENTS

 

The Company classifies its business interests into five reportable segments: Franchising, Manufacturing, Retail Stores, U-Swirl and Other. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 to the Company’s consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended February 28, 2019. The Company evaluates performance and allocates resources based on operating contribution, which excludes unallocated corporate general and administrative costs and income tax expense or benefit. The Company’s reportable segments are strategic businesses that utilize common merchandising, distribution, and marketing functions, as well as common information systems and corporate administration. All inter-segment sales prices are market based. Each segment is managed separately because of the differences in required infrastructure and the differences in products and services:

 

 

 

Revenue from one customer of the Company’s Manufacturing segment represented approximately $1.4 million, or 16.3 percent of the Company’s revenues from external customers during the three months ended May 31, 2019 compared to $1.3 million, or 15.2 percent of the Company’s revenues from external customers during the three months ended May 31, 2018.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

 

NOTE 8 – GOODWILL AND INTANGIBLE ASSETS

 

Intangible assets at May 31, 2019 and February 28, 2019 consist of the following:

 

 

Effective March 1, 2002, under Accounting Standards Codification Topic 350, all goodwill with indefinite lives is no longer subject to amortization. Accumulated amortization related to intangible assets not subject to amortization is a result of amortization expense related to indefinite life goodwill incurred prior to March 1, 2002.

 

Amortization expense related to intangible assets totaled $176,544 and $211,287 during the three months ended May 31, 2019 and 2018, respectively.

 

During the year ended February 28, 2019, the Company reviewed its estimates of the future economic life of certain intangible assets. As a result of this review, the Company accelerated the rate of amortization of certain intangible assets to better reflect their expected future value. Consistent with the treatment of a change in estimate, the new rate of amortization of intangible assets will be applied to future periods.

 

At May 31, 2019, annual amortization of intangible assets, based upon the Company’s existing intangible assets and current useful lives, is estimated to be the following:

 

 

 

NOTE 9 – COSTS ASSOCIATED WITH COMPANY-OWNED STORE CLOSURES

 

Costs associated with Company-owned store closures were comprised of asset disposal and impairment costs of $58,188 for the three months ended May 31, 2018, relating to the closure and planned closing of certain underperforming Company-owned locations.

 

There were no comparable costs incurred during the three months ended May 31, 2019.

 

 

NOTE 10 – NOTE PAYABLE

 

The Company’s long-term debt is comprised of a promissory note, the proceeds of which were loaned to SWRL and used to finance SWRL’s business acquisitions. As of May 31, 2019, approximately $830,000 was outstanding under this promissory note. This promissory note matures in January 2020.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

Additionally, the promissory note is subject to various financial ratio and leverage covenants. As of May 31, 2019, the Company was in compliance with all such covenants.

 

As of May 31, 2019 and February 28, 2019, notes payable consisted of the following:

 

 

 

NOTE 11 – LEASING ARRANGEMENTS

 

The Company conducts its retail operations in facilities leased under non-cancelable operating leases of up to ten years. Certain leases contain renewal options for between five and ten additional years at increased monthly rentals. Some of the leases provide for contingent rentals based on sales in excess of predetermined base levels. 

 

The Company acts as primary lessee of some franchised store premises, which the Company then subleases to franchisees, but the majority of existing locations are leased by the franchisee directly.

 

In some instances, the Company has leased space for its Company-owned locations that are now occupied by franchisees. When the Company-owned location was sold or transferred, the store was subleased to the franchisee who is responsible for the monthly rent and other obligations under the lease.

 

The Company also leases trucking equipment and warehouse space in support of its manufacturing operations.  Expense associated with trucking and warehouse leases is included in cost of sales on the consolidated statements of income.

 

ASU 2016-02 allows, as a practical expedient, the retention of the classification of existing leases as operating or financing. All of the Company’s leases are classified as operating leases and that classification has been retained upon adoption. The Company does not believe the utilization of this practical expedient has a material impact on lease classifications.

 

The Company accounts for payments related to lease liabilities on a straight-line basis over the lease term. As of May 31, 2019 and 2018 lease expense recognized in the Consolidated Statements of Income was $238,666 and $265,426, respectively.

 

The amount of the Right of Use Asset and Lease Liability recorded upon the adoption of ASU 2016-02 was $3.3 million. The lease liability reflects the present value of the Company’s estimated future minimum lease payments over the life of its leases. This includes known escalations and renewal option periods reasonably assured of being exercised. Typically, renewal options are considered reasonably assured of being exercised if the sales performance of the location remains strong. Therefore, the Right of Use Asset and Lease Liability include an assumption on renewal options that have not yet been exercised by the Company, and are not currently a future obligation. The Company has separated non-lease components from lease components in the recognition of the Asset and Liability except in instances where such costs were not practical to separate. To the extent that occupancy costs, such as site maintenance, are included in the Asset and Liability, the impact is immaterial. For franchised locations, the related occupancy costs including property taxes, insurance and site maintenance are generally required to be paid by the franchisees as part of the franchise arrangement. In addition, the Company is the lessee under non-store related leases such as storage facilities and trucking equipment. For leases where the implicit rate is not readily determinable, the Company uses an incremental borrowing rate to calculate the lease liability that represents an estimate of the interest rate the Company would incur to borrow on a collateralized basis over the term of a lease. The weighted average discount rate used for operating leases was 3.4% as of May 31, 2019. The total estimated future minimum lease payments is $3.6 million.

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

As of May 31, 2019, maturities of lease liabilities for our operating leases were as follows:

 

 

 

NOTE 12 – REVENUE FROM CONTRACTS WITH CUSTOMERS.

 

Effective March 1, 2018, the Company adopted ASC 606. ASC 606 provides that revenues are to be recognized when control of promised goods or services is transferred to a customer in an amount that reflects the consideration expected to be received for those goods or services. This new standard does not impact the Company's recognition of revenue from sales of confectionary items to its franchisees and others, or in its Company-owned stores as those sales are recognized at the time of the underlying sale and are presented net of sales taxes and discounts. The standard also does not change the recognition of royalties and marketing fees from franchised or licensed locations, which are based on a percent of sales and recognized at the time the sales occur. The standard does change the timing in which the Company recognizes initial fees from franchisees and licensees for new franchise locations and renewals that affect the term of the franchise agreement.

 

Initial Franchise Fees, License Fees, Transfer Fees and Renewal Fees

 

The Company's policy for recognizing initial franchise and renewal fees through February 28, 2018, was to recognize initial franchise fees upon new store openings and renewals that impact the term of the franchise agreement upon renewal. In accordance with the new guidance, the initial franchise services are not distinct from the continuing rights or services offered during the term of the franchise agreement, and will be treated as a single performance obligation. Beginning March 1, 2018, initial franchise fees are being recognized as the Company satisfies the performance obligation over the term of the franchise agreement, which is generally 10-15 years.

 

Gift Cards

 

The Company’s franchisees sell gift cards which do not have either expiration dates, or non-usage fees. The proceeds from the sale of gift cards by the franchisees are accumulated by the Company and paid out to the franchisees upon customer redemption. The Company has historically accumulated gift card liabilities and has not recognized breakage associated with the gift card liability. The adoption of ASC 606 requires the use of the “proportionate” method for recognizing breakage, which the Company has not historically utilized. Upon adoption of ASC 606 the Company began recognizing breakage from gift cards when the gift card is redeemed by the customer or the Company determines the likelihood of the gift card being redeemed by the customer is remote (“gift card breakage”). The determination of the gift card breakage rate is based upon Company-specific historical redemption patterns.

 

On May 31, 2019, annual revenue expected to be recognized in the future, related to performance obligations that are not yet fully satisfied, are estimated to be the following:

 

 

 

ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. AND SUBSIDIARIES

NOTES TO INTERIM (UNAUDITED) CONSOLIDATED FINANCIAL STATEMENTS

 

 

NOTE 13 – DISAGGREGATION OF REVENUE

 

The following table presents disaggregated revenue by method of recognition and segment:

 

 

 

 

 

 

 

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